Commissioners of Inland Revenue v Scottish Provident Institution
| Jurisdiction | Scotland |
| Judgment Date | 03 July 2003 |
| Date | 03 July 2003 |
| Court | Court of Session (Inner House - First Division) |
[2003] ScotCS 188.
Court of Session (Inner House).
Lord President Cullen of Whitekirk, Lady Cosgrove and Lord Eassie.
Gerry Moynihan QC and Jane Paterson (instructed by Solicitor of Inland Revenue) for the Crown.
Colin Tyre QC (instructed by Maclay Murray & Spens) for the taxpayer.
The following cases were referred to in the opinion of the court:
Barclays Mercantile Business Finance Ltd v Mawson (HMIT) UNKTAX[2002] EWCA Civ 1853; [2003] BTC 81
Chevron UK Ltd v IR Commrs TAX[1995] BTC 8034
Citibank Investments Ltd v Griffin (HMIT) TAX[2000] BTC 323
Craven (HMIT) v White TAXELR[1988] BTC 268; [1989] AC 398
Edwards (HMIT) v Bairstow ELRTAX[1956] AC 14; 36 TC 207
Furniss (HMIT) v Dawson TAXELR[1984] BTC 71; [1984] AC 474
HSBC Life (UK) Ltd v Stubbs (HMIT) SCD(2001) SpC 295
Jenks v Dickinson (HMIT) TAX[1997] BTC 286
Luke v IR Commrs ELRSC[1963] AC 557; 1963 SC (HL) 65
Westmoreland Investments Ltd v MacNiven (HMIT) UNKTAXELR[2001] UKHL 6; [2001] BTC 44; [2003] 1 AC 311
WT Ramsay Ltd v IR Commrs ELR[1982] AC 300
Corporation tax - Capital gain - Allowable loss - Tax avoidance - Taxation of bonds and gilts - Loan relationships - Debt contracts and options - Cross-options and collateral loan - Taxpayer entered into scheme in 1995 to create loss for tax purposes by creating debt contracts whereby options granted and premiums paid in respect of gilts - Options exercised on 1 April 1996 when new tax regime came into effect - Under new tax regime June 1995 premium left out of account in calculating profit on exercise of option contracts - Option deemed to have commenced on 1 April 1996 - Whether loss arising from cross-options allowable in calculating corporation tax liability - Whether cross-options to be regarded as single composite transaction with no commercial purposes other than tax saving scheme - Whether options self-cancelling - Whether options only exercisable together - Whether mark to market basis of accounting applicable - Finance Act 1994,Finance Act 1994 section 147A subsec-or-para 2 section 150A subsec-or-para 5 section 155 subsec-or-para 1 section 156 subsec-or-para 3 section 177 subsec-or-para 2s. 147A(2), 150A(5), (11), 155(1), (2), (4), 156(3), 177(2).
This was an appeal by the Inland Revenue from a decision of the special commissioners ((2002) SpC 315) that, as a matter of principle, a loss of about £20m was allowable where the taxpayer, before the coming into force of new legislation in relation to the taxation of debt contracts and options in the Finance Act 1996, paid £30m to a bank to acquire an option which when exercised gave rise to an income loss under s. 155(4) of the Finance Act 1994.
In May 1995 the Inland Revenue published a consultative document entitled "The Taxation of Gilts and Bonds" proposing a major simplification of the applicable tax rules including those for derivatives such as options, by treating profits as of an income nature with losses being relievable against income. The rules for corporate holders would parallel the rules for new financial instruments in the Finance Act 1994. Thereafter Citibank proposed to the taxpayer institution a scheme which had as its object the creation of expenses within the new proposed tax regime. In June 1995 the parties entered into two option agreements: under option A, Citibank paid £29.5m to the taxpayer for the option to acquire £100m 8% Treasury 2000 ("the gilt") at a price of 70 between 30 August 1995 and 1 April 1996. By a collateral agreement the taxpayer paid £20m by way of interest-free loan to Citibank, repayable when option A was exercised. Citibank was also paid a fixed fee for the scheme and ten per cent of the tax saving. The option prices were based on a price for the gilt of 99.75 which was the price on the date the taxpayer's board approved the transaction.
The scheme was intended to work as follows: the price paid for option A before the new legislation came into force would fall out of account; the receipt was not taxable because options over gilts were not liable to tax on capital gains. After the commencement of the new tax regime the taxpayer's loss of £30m on the sale of the gilt would be an income loss. The profit of £10m on option B would reduce the loss to £20m. The purpose of option B was to hedge the transaction. The new legislation came into force on 1 April 1996. Both options were exercised and the stock deliveries and all sums due were netted off for settlement purposes and no money or stock changed hands.
The Revenue assessed the taxpayer to corporation tax on the basis that the £20m loss was not allowable. The special commissioners allowed the taxpayer's appeal against that assessment ((2002) SpC 315). They decided that the transaction relating to each of option A and option B was a "qualifying contract" for the purposes of Pt. II of the 1994 Act, as amended; and that profits and losses in respect of each transaction fell to be computed on a mark to market basis in accordance with s. 155(4). They further concluded that, for the purposes of that computation, in the case of option A, amount A was £70m and amount B was £104m (under s. 155(4)(a)(i) and (b)(i) respectively). In the case of option B, amount A was £104m and amount B was £90m. This yielded a loss in the case of option A of £34m and a profit in the case of option B of £14m, and thus an overall loss of £20m. The Revenue appealed to the Court of Session.
Held, dismissing the appeal:
1. It was clear from s. 155 of the 1994 Act that the ascertaining of profit or loss was to be carried out by reference to the particular qualifying contract and accounting period. Subsections (1) and (2) stipulated what was to be regarded as profit or loss and required that amounts A and B were to be ascertained on one or other of two bases. In the case of the mark to market basis, each of those amounts, and hence the difference between them, depended on changes in value, if any, over the accounting period and payments, if any, due and payable to or by the company in that period.
2. In those circumstances, s. 155(2) employed a legal concept, being a construct which had a specific statutory meaning. The artificial framework for which the section provided did not indicate that a commercial meaning fell to be given to "loss", let alone that the relationship between one qualifying contract and another had to be considered from a commercial viewpoint, in order to determine whether there was any true "loss". It followed that the Revenue's approach would be rejected since it involved ascertaining whether there was a commercial or business purpose rather than tax avoidance for the separate treatment of the transactions which were components of the scheme. The reference in s. 156(3) to "normal accountancy practice" did not entail that the concept of "loss" for the purpose of s. 155 was to be interpreted in accordance with that practice. (Westmoreland Investments Ltd v MacNiven (HMIT) [2001] BTC 44 considered.)
3. Even if the concept of "loss" in s. 155(2) fell to be treated as a commercial concept, it did not follow that the special commissioners were in error in treating options A and B as separate, bearing in mind the findings as to the risk created for Citibank, in particular the genuine commercial possibility that due to movements of interest rates and gilt prices, it would be in the interests of Citibank to refrain from exercising option A or exercising it on a date different from the exercise by the taxpayer of option B. There was also a genuine commercial possibility and a real practical likelihood that the two options would be dealt with separately, and that option B would not be exercised by the taxpayer.
4. The special commissioners could not be faulted for applying the test of genuine commercial possibility or practical likelihood. While there was no doubt that the scheme was intended to avoid tax, it was important to put it in the context of the change in the law which was brought about by the introduction of debt contracts into the category of "qualifying contracts". The essence of the Citibank scheme was to secure the treatment as a loss for tax purposes of the difference between the value of the gilts transferred by the taxpayer to Citibank and the price payable by Citibank for those bonds. Since it was not subject to tax either before or after the introduction of the new legislation, the premium which the taxpayer received for the granting of option A could not be brought into account so as to eliminate or reduce that loss. That was a situation created by the drafting of the legislation. Option B, on the other hand, was not conceived as having any tax advantage to the taxpayer. It was not arranged to enable it to avoid the taxation of profit or to secure relief against loss. According to the findings of the special commissioners it was hedging the risk relating to option A. It followed that it was not essential to the scheme that option B should be exercised at the same time as option A.
5. The options had not been varied by an agreement constituted by an exchange of letters dated 20 and 28 March 1996 between the parties. Accordingly on 1 April 1996 the parties held still held the rights or were subject to duties under those transactions and options A and B were both qualifying contracts as at 1 April 1996.
6. As to whether it was appropriate to attach a nil value to each option on 1 April 1996, it was not justifiable to give an extended meaning to the deeming provision of s. 147A(2) by applying it to s. 156(3). So far as s. 156(3) was concerned, the value of a contract was dependent on the application of normal accountancy practice which was not required to be modified. Moreover, the extension of s. 147A(2) to s. 156(3) would have made the transitional provisions unnecessary. Further, s. 177(2) provided the link not only to s. 155(7) but to the charging...
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